compatibility of national legislation with Economic and Monetary Union (EMU) rules: independence of the national central bank, prohibition of monetary financing, compatibility with the statutes of the European System of Central Banks (ESCB) and of the European Central Bank (ECB)

The current report was prepared upon the request of Latvia, as the next regular Convergence Report is only due next year. According to the EU Treaty, the Commission prepares a report every two years, or upon request by a Member State. The last full report was published in May 2012 (IP/12/553).

What is the assessment of the Commission?

The Commission concludes that Latvia meets the criteria for adopting the euro (for details of the assessment please see IP/13/500). As a consequence, the Commission is proposing to the Council that Latvia adopts the euro on 1 January 2014. The formal decision is expected to be taken by EU Finance Ministers on 9 July.

In legal terms, the Commission proposes to the Council that Latvia exits its derogation from the euro. As Latvia did not meet the conditions for entry to the euro area when it joined the EU in May 2004 its Treaty of Accession allowed it time to make the necessary adjustments. So it is a Member State of the Economic and Monetary Union with a 'derogation'1, as are Bulgaria, the Czech Republic, Lithuania, Hungary, Poland, Romania and Sweden.

What are the convergence criteria?

The convergence criteria are set out in Art. 140(1) of the Treaty.

The Maastricht convergence criteria (in simplified terms)

WHAT IS MEASURED

HOW IT IS MEASURED

CONVERGENCE CRITERIA

Price stability

Harmonised consumer price

inflation rate

Not more than 1.5 percentage points above the rate of the three best performing EU countries

Sound public finances

Government deficit as % of GDP

Reference value: not more than 3%

Sustainable public finances

Government debt as % of GDP

Reference value: Not more than 60%

Durability of convergence

Long-term interest rate

Not more than two percentage points above the rate of the three best performing EU countries in terms of price stability

Exchange rate stability

Deviation from a central rate

Participation in the European Exchange Rate Mechanism for two years without severe tensions

Sustainability is a key aspect of the assessment of the Maastricht convergence criteria.

Is there any other report complementing the Commission's assessment?

Yes, in line with its mandate the European Central Bank (ECB) has also prepared a report assessing Latvia's readiness for the euro based on the convergence criteria. It is published today.

What are the next steps?

As mentioned above, the Commission has today proposed to the Council of Ministers to abrogate Latvia's derogation from the euro.

Moreover, the Council will receive a recommendation from its euro area Member States, deciding by qualified majority in accordance with Art. 238(3)(a) of the Treaty on the Functioning of the European Union (TFEU).

The Council will then take a formal decision on the abrogation of the derogation in July after having consulted the European Parliament and after EU leaders have held a discussion in the European Council on 28-29 June. This would allow Latvia sufficient time for thorough technical preparations to introduce the euro on 1 January 2014.

Following the decision on the abrogation of the derogation, the Council will also have to irrevocably fix the exchange rate and decide on other measures necessary for the introduction of the euro in Latvia, based on Commission proposals and after having consulted the ECB.

How will the decision on the conversion rate be taken?

The Commission plans to propose to the Council a possible conversion rate for the Latvian lats in early July. The formal decision would be taken on 9 July, by the euro area Finance Ministers and Latvia. The decision is taken by unanimity, meaning that all ministers and Latvia have to agree on the conversion rate to be adopted.

Once Council takes the formal decision on Latvia's euro adoption, what must still be done in the country by 1 January 2014?

Latvia must carefully prepare the changeover to the euro by implementing its national changeover plan, which provides all the details for the organisation of the introduction of the euro and the withdrawal of the lats. It sets, for instance, the timetable of supplies of euro cash to commercial banks and to retailers, the rules for cash exchanges for citizens to be applied before and after its "day one" of the euro, the strategy for adapting bank accounts, electronic payments systems and ATMs to the euro etc. Importantly, the Latvian authorities must also carefully put in place measures and information campaigns aimed at preventing changeover-related price increases.

What will the euro change in terms of Latvia's monetary policy?

Latvijas Banka, the national central bank of Latvia, would become a member of the Eurosystem, the central banking system of the euro area.

In accordance with the Statute of the European System of Central Banks (ESCB) and of the European Central Bank (ECB), Latvijas Banka would have to pay up the remainder of its contribution to the capital of the ECB and transfer its contribution to the foreign reserve assets of the ECB. Upon adoption of the euro, the Latvian monetary financial institutions would be integrated into the euro area banking system and be able to participate in ECB open market operations.

The Governor of the Central Bank of Latvia would become member of the Governing Council of the ECB.

Latvia would also have the right to design Latvia-specific euro coins for circulation throughout the euro area.

When will Latvia become a member of the European Stability Mechanism?

Once the Council decision on euro adoption is taken, Latvia may apply to become a Member of the European Stability Mechanism (ESM). From the entry into force of the Council decision, and following the approval by the ESM Board of Governors, membership becomes effective once it has deposited the instrument of ESM accession. The Board of Governors will have agreed the detailed technical terms of this accession, including an adaptation of the capital key, taking into account Latvia’s accession.

When will Latvia need to fulfill the obligations of the "Two-Pack" ?

If Latvia joins the euro area on 1 January 2014, it would be immediately subject to the obligations under the 'Two-Pack' legislation and would, in particular, be expected to submit its draft budgetary plan for the year 2015 by 15 October 2014.

The following new obligations have been introduced for euro area Member States with the entry into force of the 'Two Pack' legislation:

In terms of the budgetary framework: macroeconomic forecasts need to be independently produced or endorsed; compliance with national fiscal rules should be monitored by independent bodies.

Closer coordination of their budgetary policies requires all Member States of the euro area to send to the Commission for its assessment their draft budgetary plans for the following year by 15 October every year; they also share ex ante their debt issuance plans.

Specific requirements are applicable when a country is under the Excessive Deficit Procedure, as well as when threats to its financial stability are detected.

What else changes as regards fiscal surveillance and policy coordination if Latvia adopts the euro?

The Treaty on Stability, Coordination and Governance (TSCG) in the EMU would become binding in its entirety, including the Fiscal Compact. Latvia is a contracting party of the TSCG and has already ratified it. However, some titles of the Treaty are only binding for euro area Member States, such as the Fiscal Compact, that non-euro area Member States can choose not to be bound by. This was the case of Latvia when ratifying the TSCG: when entering in the euro area, it would become subject to the Treaty in its entirety. This includes, inter alia, the obligation to enshrine in national law a budget-balance rule based on the Stability and Growth Pact's medium-term objective and the automatic correction mechanism in case of deviations, under the monitoring of independent institutions. Another obligation deriving from the TSCG for euro area Member States is the commitment to support recommendations of the Commission to the Council in the context of an Excessive Deficit Procedure for a euro area Member State (which is based on the deficit criterion), unless a qualified majority of euro area Member States is against the recommendation.

Euro area Member States can be subject to financial sanctions if they breach their budgetary obligations. Since the end-2011 reform of the Stability and Growth Pact this already applies from when a country significantly deviates from the adjustment towards its medium-term budgetary objective.

When will Latvia become a Member of the Single Supervisory Mechanism?

At the latest with the adoption of the euro, Latvia would become a participating member of the Single Supervisory Mechanism (SSM), which is currently being established and is expected to be fully operational 12 months after the entry into force of the respective Regulation.

Which countries that joined the EU in 2004 or 2007 have already adopted the euro?

So far, five of the twelve Member States that joined the EU in 2004 or 2007 have already adopted the euro. Slovenia did so in 2007, Cyprus and Malta in 2008, Slovakia in 2009 and Estonia in 2011. Currently around 330 million people in 17 countries use the euro: Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia, and Spain. The euro area's GDP amounts to €9.5 trillion (2012).

What about the other countries?

In principle, all Member States that do not have an opt-out clause (i.e. United Kingdom and Denmark) have committed to adopt the euro once they fulfil the necessary conditions. The Member States that acceded to the EU in 2004 and 2007, after the euro was launched, did not meet the conditions for entry to the euro area at the time of their accession. Therefore, their Treaties of Accession allow them time to make the necessary adjustments. It is up to individual countries to calibrate their path towards the euro, and no timetable is prescribed. However, it is important not to underestimate the role of euro adoption as a medium-term policy anchor, and the risks to credibility and confidence of derailing the convergence process.

What are the benefits of adopting the euro?

The benefits of the euro are diverse and are felt on different scales, from individuals and businesses to whole economies. They include:

Stable prices: In the 1970s and 1980s many EU countries had very high inflation rates, some of 20% and more. Inflation fell as they started preparing for the euro and, since its introduction, has remained around 2% in the euro area. Price stability means that citizens’ purchasing power and the value of their savings are better protected.

A more transparent and competitive market: The euro brings price transparency to the single market. Consumers can easily compare prices across borders and find the best price for a product or service. Greater price transparency also increases competition between shops and suppliers, keeping downward pressure on prices.

The Single Euro Payments Area: The costs of sending money in euro to another euro area country have been reduced since the introduction of the euro and EU rules on cross-border euro payments in 2001.

Lower travel costs: The costs of exchanging money at borders have disappeared in the euro area. This makes it cheaper to travel. In the 1990s, a person travelling through all the EU countries and exchanging money at every border would lose up to half their money in exchange costs – without making a single purchase.

More cross-border trade: Within the euro area, there is no need for businesses to work in different currencies. Before the euro, a company would need to take account of the risk of fluctuating exchange rates and currency exchange costs alone were estimated at €20 to €25 billion per year in the EU. With no exchange risks or costs, cross-border trade within the euro area is encouraged. Not only can companies sell into a much larger ‘home market’, but they can also find new suppliers offering better services or lower costs.

More international trade: The euro area is also a large and open trading block. This makes doing business in euro an attractive proposition for other trading nations, which can access a large market using one currency. Euro-area companies also benefit because they can export and import in the global economy using the euro. This reduces the risk of losses caused by global currency fluctuations.

Better access to capital: The euro gave a large boost to the integration of financial markets across the euro area. Capital flows more easily because exchange rate risk has disappeared. This allows investors to move capital to those parts of the euro area where it can be used most effectively.

Does the euro changeover increase prices?

The changeover process in 2002 and more recently, when Slovenia, Malta, Cyprus, Slovakia, and Estonia became members of the euro area is estimated to have increased prices by an additional 0.1 to 0.3 percentage points. So if the average price rise from one year to the next was €2.30 for a €100 basket of purchases, then no more than thirty euro cents of this increase was due to the euro.

When the Maastricht Treaty was politically approved by the Heads of State or Government at the European Council in Maastricht in 1991, the average inflation rate in the euro area was around 4%. Since the start of the third stage of Economic and Monetary Union on 1 January 1999, annual inflation in the euro area – as measured by the harmonised index of consumer prices (HICP) – has averaged 2%.

Nevertheless, Latvian authorities have to try to reduce existing changeover risks related to rounding, menu prices, and other forms of possible rent seeking on the side of businesses. Experience shows that unjustified price hikes are most pronounced in the service sector where competition from imports is limited. Proper action is therefore needed for strong enforcement of competition rules, price monitoring, providing sufficient information to customers, and involvement of stakeholders in fair pricing campaigns.

Will euro adoption impede Latvia's national sovereignity?

On the contrary, euro adoption will mean Latvia can participate for the first time in decision-making on issues that already affect the country, due to its eight-year-old peg to the euro. Key euro area-related decisions will continuously be taken by the national government representatives in fora like the Eurogroup (meeting of euro area finance ministers), so the Latvian authorities will have a significant policy-making impact as they will participate in these meetings.

Will euro adoption have an impact on post-programme missions to Latvia?

After the successful conclusion of the EU/IMF-led financial assistance programme, Latvia is under post-programme surveillance for as long as repayments of the EU loan are still below 75% of the loan. Commission staff undertake twice yearly missions to the country to monitor progress on structural reforms and assess whether there might be any difficulties to keep the repayment schedule. Adoption of the euro does not change the existing post-programme surveillance since, according to a transitional provision in the Two-Pack2 regulation, Member States already under post-programme surveillance when the Regulation entered into force are subject to the post-programme surveillance rules, conditions and procedures applicable to the financial assistance from which they benefit.

The Member States that have not yet fulfilled the necessary conditions for the adoption of the euro are referred to in the Treaty on the Functioning of the European Union as “Member States with a derogation”, unlike Denmark and the UK, which negotiated opt-out arrangements in the Maastricht Treaty. See section "What about other countries?"

The Two-Pack, which is made up of two regulations, entered into force on 30 May. Its aim is to further strengthen budgetary surveillance and coordination of economic and budgetary policy in the euro area.